SCENESETTER FOR SECRETARY PAULSON'S VISIT TO

C O N F I D E N T I A L LONDON 003539 SIPDIS NOFORN SIPDIS FOR SECRETARY PAULSON FROM AMBASSADOR TUTTLE E.O. 12958: DECL: 09/11/2017 TAGS: ECON EFIN PREL UK SUBJECT: SCENESETTER FOR SECRETARY PAULSON'S VISIT TO LONDON SEPTEMBER 17-18 Classified By: Ambassador Robert H. Tuttle for reasons 1.4 b & d ¶1. (C/NF) SUMMARY AND INTRODUCTION: Your visit is much welcomed. You come to London at a critical moment. The UK is adjusting to the change in leadership from Tony Blair to Gordon Brown, who has displayed calm confidence in addressing key domestic challenges in the short period he has been Prime Minister. The bilateral relationship is also adjusting to the change in leadership. Political commentators have speculated about Brown's need to appease his domestic audience with a cooler public stance towards the U.S. Administration. While his Scottish-demeanor is certainly not as openly warm as Tony Blair's, Brown and his team have been careful to assure us publicly and privately that our relationship is paramount. Brown is driven by a sense of purpose, rather than power. His impatience to press forward his own agenda in the absence of a clear timetable on his political future, combined with a more reserved temperament, will likely lead to the occasional tussle between our governments. ¶2. (C/NF) The timing of your visit is also crucial given the turmoil in the financial markets, which is front page news in the UK. Both the Prime Minister and the Chancellor will be keen to discuss how to stabilize the markets and avoid liquidity problems, as well as let you know the results of the EU Finance Ministers meeting in Portugal this week-end and how they have handled the first request, from a major mortgage lender, of this crisis for liquidity support in the UK. The war in Afghanistan and in Iraq will be on Brown's mind with General Petraeus and Ambassador Crocker due in London just after your visit and Brown scheduled to present his plans for Iraq to Parliament in October. The British are also worried about Iran and how to ratchet up the pressure on the regime. You will find common ground with Brown and Darling on the importance of promoting free trade and open investment markets. Brown continues to place great emphasis on alleviating poverty in the developing world and has endorsed climate change as a key priority for his government. ¶3. (C/NF) Your visit gives you the opportunity to gauge personally Brown's and Darling's commitment to the solid U.S.-UK relationship, and to convey to them and the British public our appreciation and support. Your joint press appearance with the Chancellor should go a long way to calming nervousness about the financial markets; the bankers are nervous and looking for leadership. This is an opportunity to show strength on Iran and Afghanistan and to move our agenda on Iran forward, to reiterate the importance of the Doha Development Agenda, to show a joint commitment to an open investment regime, and to continue to take on the tough issues that our nations have tackled so well together over the years. END SUMMARY AND INTRODUCTION PM Brown's strong start -------------- ¶4. (C/NF) Prime Minister Brown got off to a solid start upon succeeding Tony Blair in June. The British public welcomed his serious, workmanlike approach after the perceived slickness of his predecessor. They also liked his balancing act with President Bush after the perceived "subservient" Blair relationship with Washington: working together to advance shared interests, while maintaining some personal distance. Brown was seen to handle early challenges with calm competence: the attempted car bombings in London and Glasgow failed and a quick investigation produced results; one outbreak of foot-and-mouth disease was quickly contained (although another reared its head on September 12 with a confirmed case near the earlier outbreak); and the worst flooding in sixty years drew an energetic response from the Government. ¶5. (C/NF) Meanwhile, the opposition Conservatives were in disarray over leader David Cameron's efforts to drag the party to the center. At one point, Brown's lead in the opinion polls (the "Brown Bounce") triggered speculation about a snap election this fall. That lead has now shrunk, and with it the prospect - never likely - of a fall election. Now, the trade unions affiliated with the ruling Labour Party are threatening an "autumn of discontent" over the PM's insistence on holding public-sector pay raises below the rate of inflation and his resistance to demands for a referendum on the EU Treaty. Standing up to the unions could actually help Brown with the wider public. Impact on London of turmoil in financial markets -------------- --- ¶6. (C/NF) The financial sector is nervous about the turbulence in the sector triggered by the subprime mortgage market problems in the United States. The issue in the UK is not that suspect U.S. lending practices to subprime borrowers have been adopted by UK lenders, but rather that the U.S. subprime problem has made UK banks cautious about interbank lending, which is drying up. Darling made his first public statement on this issue in a September 13 interview in which he said that primary responsibility for handling the credit crisis lay with the banks which need to examine carefully their lending policy. He said he would discuss with EU finance ministers over the weekend and with you on Monday proposals to help maintain global financial stability and avoid future liquidity crisis. Mervyn King, Governor of the Bank of England, signaled in a September 12 letter in advance of his September 20 appearance at a Parliamentary hearing, that the Bank would not bail out banks and financial institutions. Hector Sants of the Financial Services Authority (FSA) said privately that its "regulatory toolbox" is not lacking with regard to regulating the UK mortgage market and securitized mortgage lending. The issue may be one of better assessing and valuing the risks inherent in such lending. ¶7. (C/NF) In a move that surprised both the market and the public, on September 14, the Bank of England, in consultation with the FSA and Her Majesty's Treasury, agreed to provide a "liquidity support facility" to Northern Rock, a large mortgage company in the UK. This decision is in keeping with what King said in his September 12 letter was appropriate for central banks. As a lender of last resort, the Bank provided this assistance against "good collateral at a penalty rate to an individual bank facing temporary liquidity problems, but that is otherwise regarded as solvent." Darling, and others, hit the media with the message that there is no need to panic, that Northern Rock is solvent but suffering from a short term squeeze, and that the Bank of England has an appropriate tool to address the situation, which it has done. Nonetheless, there is still a growing degree of nervousness, and London's over-heated property market may finally cool off a bit. Iraq -------------- ¶8. (C/NF) General Peter Petraeus and Ambassador Ryan Crocker will stop over in London on their way back to Iraq on September 18 for meetings with Prime Minister Brown, Foreign Secretary David Miliband, and Defense Secretary Des Browne. SIPDIS The fact that this is their only stop before returning to Baghdad underscores the importance both we and the British attach to our cooperation on Iraq. ¶9. (C/NF) The UK response to the Petraeus/Crocker testimony has been positive, with Brown himself scheduled to make a statement in response on September 14. HMG continues to stress that it is in constant contact with the USG on all Iraq-related issues, and that the UK will not leave before the job is done. Nonetheless, the British drawdown of troops in the south and withdrawal to an airbase outside of Basra, at the same time as U.S. troops surge elsewhere in Iraq, has given rise to speculation that tensions are rising between Washington and London. An August op-ed piece in the "New York Times" co-authored by Browne and Miliband was designed to staunch these questions, but HMG contacts tell us they recognize it has not succeeded. Despite these efforts, although no decision has been taken, we assess that -- ultimately -- the Brown government will pull its remaining forces in Iraq out by spring, even at the expense of a strain in relations with the United States. An August op-ed piece in the New York Times co-authored by Defence Secretary Des Browne and Foreign Secretary David Miliband was designed to staunch these questions, but HMG contacts tell us they recognize it has not succeeded. A spokesman for PM Brown was forced to address the issue once again at a September 11 press conference, insisting that the UK and U.S. are in continuous and open communication on all issues, and that the U.S. had been fully apprised of the withdrawal of UK forces from Basra Palace to the airbase outside the city beforehand. ¶10. (C/NF) Media and public speculation continues to focus on why such close allies have taken such different approaches, with some speculating that PM Brown has struck an unidentified "secret deal" with President Bush to allow most UK troops to withdraw, while keeping some minimum in the south of the country. There is also a widely held assumption that Gordon Brown will reduce the UK presence in Basra to an absolute minimum by the end of 2007. Domestically, such a move has no downsides for Brown: the Labour Party, never entirely comfortable in supporting Blair on Iraq, will be relieved; the military leadership, which has tended recently to take public its grievances on being stretched too far, will be placated; and the electorate, deeply unhappy over Iraq, will see Brown as the leader who undid Blair's mistake. Timing is important: a troop rotation is set to occur in November. A British departure from Basra by Christmas would be an asset in a spring general election. While we do not believe a decision has been made, we assess, that even with the USG urging that UK troops stay at current levels, Brown may pull them out by no later than Spring 2008. An important part of the justification will so that the UK can deploy more troops in Afghanistan. British military in Afghanistan -------------- ¶11. (C/NF) The Brown Government is thinking carefully and at the highest levels about the current situation in Afghanistan and the UK's role in future engagement. The UK deployment in Afghanistan still has public and parliamentary support, but the longer the deployment goes on the more skeptical both HMG officials and the public become about prospects for success. Foreign Secretary David Miliband plans to deliver a copy of a UK interagency review paper to Secretary Rice on the margins of UNGA in New York later this month with a view towards eliciting a U.S. response on the way forward. The UK paper will reportedly conclude that we do not yet know how to create a "functioning Afghanistan at all levels" and that coalition forces need to better understand how to build functioning government at every level -- national, regional, local and tribal. It will also discuss ISAF support for Afghan counter-narcotics efforts. Counter-narcotics is one area where we have some disagreement with HMG: the British are totally opposed to aerial spraying, but lately have indicated more willingness to consider ground spraying on the opium crop, "under the right conditions." The British mantra is that counter-narcotics and all other efforts in Afghanistan must be integrated within a comprehensive counter-insurgency strategy. Iran - The British are worried -------------- ¶12. (C/NF) Iran worries the British. They believe pressure on Iran is having an important affect, but in order to impact Iranian behavior we need to ratchet it up through the UN (where the UK is pessimistic about immediate prospects for a third UNSCR),other multilateral fora (the EU, with France as a strong ally on this issue now),and in more public pronouncements on possible sanctions. The UK emphasizes the need for unity among the "P5 plus 1" ("E3 plus 3" in its parlance),and is encouraged by France's willingness to take a tough line. In addition to briefing Brown and Darling on current U.S. thinking on Iran and a next UNSCR, you may want to raise with Darling the usefulness of financial supervision and regulatory tools in pressuring Iranian banks operating in the UK. Your Assistant Secretary Pat O'Brien was here last week to encourage the UK to step up efforts on Iran and on terrorist financing, and your FinCEN Director James Freis will be here at the same time of your visit. Close ally on terrorism finance -------------- ¶13. (C/NF) Our governments cooperate at all levels across the inter-agency spectrum on combating terrorist financing (TF.) There is little daylight between our philosophies and our approach to using financial tools to stop terrorism. What differences do exist are mainly a result of a lack of resources the UK has traditionally made available in the TF fight and having to meet a high UK evidentiary threshold. Brown has increased the TF budget and re-organized his government's efforts. Promotion of the City -------------- ¶14. (C/NF) The UK continues to believe hedge funds provide valuable risk management options and do not need regulation beyond that to which all UK-based funds are subject. HM Treasury will decide this month whether to issue a shariah-compliant sukuk (bond),which Brown hopes will positively influence Middle Eastern investors and the 1.3 million UK Muslim community. While an increasing number of officials claim London has surpassed New York as a financial center, many UK government stakeholders and UK-based financial companies view the chatter over Wall Street vs. The City as a fabrication of the financial media. UK officials contend that both New York and London must prosper in order to maintain their leadership positions in the face of emerging financial markets in China and India, but they also energetically support the City's growth. Brown and Darling Support DDA -------------- ¶15. (C/NF) Brown and Darling continue to be a fervent supporter of the Doha round and open investment in the UK. Darling, as former Secretary of State for Trade and Industry, will have insight into internal EU dynamics on the Doha Development Agenda WTO negotiations which you may wish to explore with him and Brown. Brown and Darling may ask about the perceived rise in protectionism in the United States and Europe and how we can work together to counter public concerns about globalization. Brown has argued that the UK and the EU need to be open and competitive to meet the challenges of globalization. Development - critical issue for Brown -------------- ¶16. (C/NF) Although only Prime Minister a short time, Brown has already made good on his desire to push development and climate change. After he met with the President in Camp David in July, he immediately gave a speech at the UN declaring his intention to push harder to achieve the Millennium Development Goals and released a Declaration to that effect, signed by President Bush and other leaders. He also launched an international health initiative on September 5, which we are still analyzing and are not ready to endorse. Climate change - Brown government priority -------------- ¶17. (C/NF) Along with development, climate change is a key item on Brown's "To Do" list. Climate change is a front-line, threshold in the UK, with strong support for action coming from across the political and social spectrum. All parties want to be seen as fully "green" on climate change. There is consensus for binding targets and a cap-and-trade system on carbon emissions. Many environmental financial services and trading programs reside in London. Environment Minister Phil Woolas will be Brown's personal representative to the President's September 27-28 Major Economies conference on climate change and energy security. However, the British are miffed that they were not invited as a sovereign nation, but rather as a part of the European Union's delegation, and have requested an individual invitation. Chancellor of the Exchequer Darling: "A safe pair of hands" -------------- -------------- ¶18. (C/NF) Chancellor of the Exchequer Alistair Darling, a fellow Scotsman and long-standing Brown ally, has been in the Cabinet since Labour took power in 1997 (a distinction he shares with the PM and Justice Secretary Jack Straw),as Chief Secretary to the Treasury, then Social Security Secretary, Transport Secretary, and (concurrently) Scotland SIPDIS Secretary, then Trade and Industry Secretary. Darling is SIPDIS seen as highly capable, experienced and reliable, and very discreet; he was once voted Britain's most boring politician. The relationship between Brown and his Chancellor is expected to be much smoother than the one Brown held with PM Blair. Visit London's Classified Website: http://www.state.sgov.gov/p/eur/london/index. cfm TUTTLE